Step Up to Help Reduce Taxes on Inherited Assets
If you have assets that have appreciated in value, such as stocks or real property, you could be subject to substantial capital gains taxes when you sell the assets (see chart below). However, if you leave these assets to your heirs, any gain accrued before your death would not be taxed because of the step-up in basis on appreciated assets. Here’s how it works.
Basis and Gains
The basis in an asset is typically the purchase price, plus any sales tax or other expenses associated with the purchase. Basis in real property may be adjusted upward for the cost of improvements or downward for depreciation taken for tax purposes and insurance reimbursements for casualty losses or theft.
The capital gain is the difference between the basis and the price received when selling the asset. For example, if you buy shares of stock for $50,000 and sell them for $100,000, you realize a $50,000 capital gain. If the price received is less than the basis, you would realize a capital loss.
If you leave the stock to your heirs, the basis would be set at the fair market value at the time of your death. Using the previous example, if the stock had appreciated in value to $100,000, that would be the basis for your heirs. If they later sell the stock for $120,000, they would be liable for capital gains taxes only on the $20,000 of appreciation since they inherited the shares. Conversely, if the stocks had dropped in value during your lifetime, the basis for your heirs would be stepped down.
The step-up in basis does not apply to gifts, which are subject to the carryover basis. Using the earlier example, if you gave the stock to your heirs during your lifetime, their basis would be the original $50,000 purchase price, and they would owe capital gains taxes on $70,000 of appreciation if they sold the stock for $120,000. This is an important consideration when deciding whether to gift assets or leave them as a bequest.
Some inherited assets such as cash, variable annuities, and retirement accounts are not eligible for a step-up in basis. It would be wise to consult with a tax and/or estate planning professional before taking action.